VERSACE: Can savings rate save our future?

I suspect many would agree that one of the larger issues of the last economic boom was overconsumption by consumers.

Now we can argue over responsibility - whether companies should have extended such easy credit or whether consumers should have taken it. But no matter how you slice it, consumers lived above their means and this fueled not only economic expansion, but also bubble expansion. As I touched on last week, the combination of the current economic environment, credit crunch, consumer concern over jobs and shrinking personal income means consumers now are saving.

Another factor for greater consumer savings is simple demographics. All we need to do is look at those 76 million Americans born between 1946 and 1960 who are part of the baby boom generation. The baby boomers are the cohort sending children to college and likely approaching what used to be retirement years. At the same time, baby boomer savings were decimated in the past year. We have all lamented about how hard it must be to have to send a child to college or how, given the market drop in the past year, people may not be able to afford to retire.

Clearly, people need to save to get back onto their feet as well as protect themselves in these uncertain times. Are we getting better in terms of savings?

Sort of, but not really, is the short answer given the latest statistics from the Federal Reserve.

I say “sort of,” because the savings rate, which had fallen below zero in 2005, was back to 6.9 percent of disposable income in May before dipping to 4.6 percent in June. At the same time, however, total household indebtedness peaked at the end of 2007 at 132 percent of disposable income, up substantially from 36 percent in 1952 and even 69 percent in the middle of 1985. Consumers have been making some progress in reducing the burden, as the ratio had fallen to 124 percent at the end of March.

The silver lining here is consumers have started to shift their behavior from one of “want” to one of “need to have.”

At the same time, I find it rather interesting that Treasury Secretary Timothy F. Geithner asked Congress to increase the $12.1 trillion debt limit last week. The reason being “the current debt limit could be reached as early mid-October. Increasing the limit is important to instilling confidence in global investors.” As a backdrop, the nonpartisan Congressional Budget Office said last week that the federal government’s budget deficit reached $1.3 trillion through the first 10 months of fiscal 2009, on track to reach a record high of $1.8 trillion for the year.

As background, if Congress were to agree with the Treasury’s request, it would mark the second increase in the debt ceiling this year following the passage of the $787 billion economic stimulus package. That increased the debt ceiling to $12.1 trillion and, as of Aug. 7, the federal debt outstanding totaled roughly $11.7 trillion.

In my view, there are two primary issues at hand. First, how much of an increase is needed? Mr. Geithner didn’t offer a specific figure in his letter to lawmakers. Second, how will the deficit be repaid?

The first issue is rather important because the more debt we float as a country the more costly it could be, as a rising federal budget deficit can lead to rising interest rates. The greater the deficit, the more the Treasury borrows and the higher rates go. At the same, and as I have written in prior columns, wider deficits also give rise to inflation concerns, which also help drive interest rates higher. Evidence can be found in the yield on the Treasury’s 10-year note, a key benchmark for home mortgages and other kinds of loans including auto loans, mortgages and some corporate debt.

The yield on 10-year Treasury notes has climbed to 3.89 percent as I type this, which is head and shoulders above its 52-week low of 2.1 percent, reached in December. The underlying problem is that recent increases in interest rates could drive mortgage rates higher and increase the cost of borrowing for both businesses and the consumer. The risk is that higher interest rates torpedo an expected rebound in consumer and business spending, which would likely delay any near-term economic recovery.

The second issue of how the deficit gets repaid is one that needs to be addressed. The current administration has shared that “as soon as recovery is firmly established we will bring our fiscal deficit down to a level that is sustainable in the long term.” Odds are there are a wide variety of people who have prospective answers as to how this should be done, some of which we may agree with, and others not so much.

Stripping it down to the core, it becomes a question of tax revenue. If we adopt a simple profit and loss statement perspective, revenue is equal to product volume multiplied by product price. In this case, the product volume equals the taxable base of the population and the product price equals what the average person is paying in terms of taxes.

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About the Author

Chris Versace, the “Thematic Investor,” is the director of research at Think 20/20, an independent equity research and corporate access firm located in the Washington, D.C. area. Before Think 20/20, Mr. Versace was the portfolio manager of Agile Capital Management (ACM), a thematically driven alternative investment fund. The groundwork for ACM was laid during Mr. Versace’s tenure as senior vice president of equity ...